More grief than relief in tax plan

by David G. Tuerck

March 15, 1998

Last week, the Massachusetts House of Representatives unanimously passed a $500 million tax relief plan billed as "the state's largest tax cut ever."

The bill would reduce the tax on wages and salaries (so-called "earned" income) from 5.95 percent to 5.7 percent. This quarter-point "largest tax cut ever" is a rate reduction of 4.2 percent.

It would increase and broaden exemptions for dependents and deductions for children. And it would raise the rates on long-term capital gains while lowering them on dividends and interest.

Tax relief is in the air this year. Most candidates for governor, along with legislative leaders, have proposed some form of it.

How much? The answer from the House is, "Not very much."

The House bill represents a choice for bigger government over both popular sentiment and economic growth.

Massachusetts currently taxes personal income at some of the country's highest ratesÐ5.95 percent on wages and salaries and 12 percent on dividends and interest. Economic growth and high tax rates have brought record surpluses. For the second year in a row, Massachusetts will run a surplus of about $800 million, enough to make deeper tax cuts "affordable."

Acting Gov. Paul Celluci has proposed deeper tax cuts. He would cut both the wage and salary, and the interest and dividend tax rates to 5 percent. This would bring taxes back into line with the rates that prevailed until a revenue "emergency" of several years ago pushed tax rates to their current levels.

Deeper cuts are popular. Asked in a poll last October by the Beacon Hill Institute whether they favored cutting the tax on earned income to 5 percent, respondents answered "Yes" by a resounding 4-1 margin.

Think of state tax law as imposing a penalty on a taxpayer's decision to earn another $1,000 in income--it could be by accepting more overtime, taking on more clients, staying open longer hours or something else. The House plan would reduce this penalty by $2.50. The governor's plan would reduce it by $9.50.

This has measurable effects on the ability of Massachusetts employers to attract workers, especially important in the current tight labor market, and to invest in their businesses by acquiring equipment, buildings, computer software and the like.

The Beacon Hill Institute finds that, for example, the House plan would stimulate the creation of about 29,100 new jobs and about $5 billion in new business capital by 2001. The governor's plan would create about 110,000 new jobs and $20 billion in new business capital.

To be sure, the more powerful stimulus represented by the governor's plan would produce a greater loss in tax revenue--about $1.2 billion rather than, as under the House plan, $304 million by 2001. The choice, then, is more economic growth or more government.

Relevant to this choice are two facts: State revenues have been growing at almost twice the inflation rate for 10 years, and at current growth rates, the increase in revenues will exceed $1.2 billion by 2001Ðevidence that the state could well afford deeper tax cuts than the House wants.

Under the House plan, revenues will still grow faster than inflation. And state government will continue to grow faster than the rest of the economy.

While provisions to increase exemptions and deductions would put more money back into the pockets of taxpayers, they do little to stimulate the economy. Stimulation requires cuts in the rate on additional income, not just lower tax bills.

Finally, the House plan sends a mixed message to investors. While it cuts the tax rate from 12 percent to 5.7 percent for dividends and interest, and to 10 percent for short-term capital gains, it raises the tax rate on long-term capital gains from 3 percent next year to 5.7 percent.

The House plan raises issues of good government as well as economics. In 1994, the Legislature cut the capital gains tax in exchange for a members' pay increase. It thus made a commitment to voters and investors for less government and a better investment climate. In reneging, the House calls into question its regard for voter opinion and investor confidence.

As the tax issue passes to the Senate, there is the prospect that the Legislature will approve even less generous tax relief. There is the prospect that, with both parties willing to accept any tax cut that House and Senate leaders put forth, there will be no meaningful tax relief this year. More important, there is the prospect that voters will have been denied meaningful debates over the proper size of government and the effect of government on economic growth.

Despite what House leaders would have us believe, their plan is not the largest tax cut ever. It is the smallest they could offer without risking larger cuts later, depending on the outcome of the elections. The House offers far less than what voters want, what the state can afford or what the economy needs.

This article first appeared in the Boston Sunday Herald on March 15, 1998.